Lufthansa.ppt

Lufthansa Is it Hedging or Speculating? Case synopsis In January 1985, Lufthansa, under the chairmanship of Heinz Ruhnau purchased twenty 737 jets from Boeing. The agreed upon price was $500 million, payable in US$ on delivery of the aircrafts in one year, that is in January 1986. Case synopsis The US$ had been rising steadily and rapidly since 1980, and was approximately DM3.2/$ in January 1985. Worst case scenario: US$ continues to appreciate. Herr Ruhnau’s expectations “Like others at that time, he believed that the US$ had risen about as far as it was going to go, and would probably begin to fall by the time January 1986 rolled around.” Hedging alternatives Remain uncovered Full forward cover Option hedging Money market hedge Some combination of the above alternatives Remain uncovered It is the maximum risk approach. If e = DM 2.2/$ by January 1986, the purchase of the jets would be only DM 1.1 billion. If e = DM 4/$ the total cost would be DM 2 billion. Many firms believe that: uncovered position = currency speculation. Full forward cover This approach would have locked in an exchange rate of DM 3.2/$, with a known final cost of DM 1.6 billion. Foreign currency options A put option on the DM at DM 3.2/$, could locked in DM 1.6 billion plus the cost of the option premium (DM 96 million). The total cost of the purchase in the event the put was exercised would be DM 1.696 billion. Money market hedge Obtain the $500 million now and hold those funds in an interest-bearing account or asset until payment was due. What ultimately eliminated this alternative for consideration was that Lufthansa had several covenants that limited the types, amounts, and currencies of denomination of the debt it could carry on its balance sheet. Heinz Ruhnaus decision Ruhnau covered forward half of the exposure ($250 million) at DM 3.2/$, and left the remaining half uncovered. Expected cost as of January 1985 Outcome The dollar weakened from DM 3.2/$ to D